If you live in the U.S and are planning to subscribe to Netflix, get ready to pay more. The company announced a few days ago that all plans for audience in the U.S would see a price bump with immediate effect. The basic plan will increase from $8 to $9 per month. The standard and the 4K package will cost new subscribers $15.5 and $20 per month respectively. The Verge has a handy table showing all the hike prices that Netflix rolled out so far:
After the news broke, I saw a lot of people on Twitter bullish about Netflix’s outlook. The rationale is simple: if your customers are sticking with you AFTER you raise prices, it means you have a great business. The key underlying assumption is that Netflix viewers won’t churn or, in other words, leave. To back up this assumption, these bulls provided a chart from Antenna which allegedly shows Netflix has the lowest churn among premium streamers.
The problem is that when your entire thesis is based on a chart, you have to make sure the data is trustworthy. Unfortunately, I find Antenna’s data confusing and ambiguous for three reasons. The first reason is that there is no methodology or explanation of how they acquired this data. Take the churn chart above as an example. What does weighted average churn rate mean? What is churn weighted against? What does passive churn mean? Did they survey users or did they base this chart on credit card usage data? If it’s survey-based, how big is the survey pool and is it representative of the U.S? Plenty of questions with zero answer.
Furthermore, Antenna’s charts seem to contradict one another. While they indicate that Netflix has the most loyalty among streamers, somehow Netflix’s market share in terms of subscribers has been declining for the past few quarters. How does that happen? If Netflix’s churn was lower than that of its competitors, the company’s market share should stay the same at the very least or go up. Some may argue that Antenna may favor other streamers in a sense that if one person subscribes to both Netflix and another service, the other service will claim this subscription. Well, this argument brings us back to my first issue mentioned above: no methodology! How do we know if this argument is true?
The last issue I have with Antenna is the inconsistency of the reported data. In Q2 2021, Antenna claimed that Netflix has a market share of 29% (Figure 4). However, in their latest report for Q3 2021, Netflix’s share declined to 30% from 32% in Q2 2021 (Figure 5) . The two reports seemingly have the same methodology and feature the same number of streamers as well as the composition. My question is: what changed? How did Netflix’s Q2 2021 share go to 29% in one report to 32% in another?
These issues really call into question the assumption that Netflix’s churn is lower than its competitors.
But for the sake of argument, let’s assume that Antenna data is correct. That also means Netflix’s market share has been declining gradually. The 4-quarter rolling average net adds for US and Canada has gone down significantly since Q4 2020. Yes, Covid-19 pulled forward subscribers, but that also signals as many in the U.S are vaccinated, the macro environment is no longer favorable to Netflix as it was at the onset of the pandemic. When the number of new adds decreased despite all new releases in 2021, why does management think it’s a good idea to raise prices? Do they have any tricks up their sleeve? Or is the new price hike aimed at increasing revenue with the hope that subscribers will stay regardless?
I don’t know at this point whether this is a good strategic move for Netflix. I guess we’ll have more information this Thursday when they hold their earnings call. What I do know is that I don’t share the bullishness that many fans of Netflix stocks quickly showed after the price hike was announced. We just don’t have enough reliable information.
On Wednesday 1/12/2021, Square announced a new partnership that will enable Square Online orders in Canada to be delivered by DoorDash Drive. The new service in Canada is an extension of what Square launched in the U.S before. This is how it works: after a Square Online merchant receives an order, a DoorDash/Uber Eats courier (depending on whether you live in the U.S or Canada) will come to the merchant’s location, pick up the order and bring it to the customer. The customer can track the order through a link sent in a text message by Square. All orders with on-demand delivery will be commission-free. For every order, merchants will only pay a dispatch fee of $1.5 and a processing fee of $3.6 to Square.
At a closer look, the service is interesting to me. The sales pitch merchants will hear is very simple: work with us, become our merchant and you won’t have to waste valuable dollars on delivery staff or those expensive marketplaces with high commissions. A saving of $11 on every $50 order is highly attractive, but it’s not the whole story for merchants. Even though Square Online is free, anyone serious about operating a business will certainly need to upgrade to a higher tier. Who wants to build a brand with a “square.site” in their domain? Even a nobody like myself tries to secure a custom domain. To use a custom URL, merchants need at least a Professional plan at $12/month. Additionally, merchants can only enable PayPal checkout, product reviews or gift options with a Performance plan, which costs $26/month. Want advanced eCommerce stats regarding product performance or sales trend? Pay $72/month for the highest tier then. For Square, this means high-margin & recurring subscription revenue. For merchants, they need to think about what they may get themselves into.
Merchants must also be aware that using this on-demand delivery service with Square is different from being on Uber or DoorDash app. These marketplace apps are household names and likely bring more sales. That’s their primary value proposition. That’s how they can charge a commission of 30% per order. Since orders must be from merchants’ online stores, the task of generating sales and marketing now falls onto merchants who will have to choose between a bigger piece of a smaller pie and a smaller piece of a bigger pie. One thing that I have to say, though, is that by having customers place orders directly online, sellers can establish a precious relationship with customers, instead of ceding it to the likes of Uber or DoorDash.
What also interest me is the low dispatch fee. For every DoorDash Drive order, merchants normally pay a flat fee of $8. In this case, the dispatch fee is only $1.5. As the market leader in food delivery, DoorDash certainly has the bargaining power that they would not bend over backwards to work with Square at all costs. A drop of 81% in dispatch fees is massive, affecting DoorDash’s top and bottom line. Hence, I believe Square must compensate their partner in this agreement and make up for some of that loss. The question is: do the numbers add up for Square? It’s worth pointing out that a DoorDash Drive flat fee of $8 includes DoorDash’s standard processing fee of 2.9% + $0.3 per order. In other words, a normal $50 DoorDash Drive order will result in a processing fee of $1.75 and a dispatch fee of $6.25. A cut of $1.5 per order from Square on-demand delivery means DoorDash will lose about $4.75 per order in revenue. Let’s assume Square compensates DoorDash $3 on every order with on-demand delivery. 1,000 such orders per month (around 3 per day) for 1,000 merchants would put a dent of $3 million on Square’s financials. Square claimed to have millions of sellers. A wide adoption of this on-demand delivery service wouldn’t be financially tenable. How does Square make this work?
My hunch is that Square’s target audience for this service is small, to begin with. Any merchant wishing to use this on-demand delivery service must have a Square Online store. We can exclude medium and large-sized merchants from this population as they must already handle their online activity. Those that are in need for Square Online should be mom-and-pop or local restaurants that do not have a website or really need an upgrade and a delivery service. This market segment should be small enough for Square to offer this service and make the numbers work. I suspect that the company wants to use this offering as an opening to get these merchants to install Square POS in stores. Once Square successfully has its POS installed, the more orders merchants have, the more revenue Square generates. What intrigues me is what Square would do if merchants had too many on-demand delivery orders? Would Square terminate the service or start charging more?
This service from Square offers great benefits to small merchants and really differentiates the company from its rivals like PayPal. I don’t have access to their financials and breakdown on this specific service, but my guess is that because the target audience is very small to begin with, it won’t move the needle much. Is this a threat to Olo? I don’t think it is. Olo’s bread and butter at the moment is franchises with multiple locations. Their business doesn’t hinge on who powers merchant’s websites. What matters is that Olo offers a centralized system helping merchants deal with the likes of Uber, GrubHub and DoorDash efficiently. Square’s on-demand delivery requires that merchants have to build online presence with Square. It’s a different game.
App Annie released a report named State of Mobile 2022, offering a comprehensive view on the app economy around the world. The report is very informative with lots of data and I really recommend you have a look, but there are a couple of things that make me hesitant to draw any lesson:
Hours spent on app is only on Android devices; which doesn’t provide a complete picture of app usage as iOS is a huge ecosystem
I couldn’t find the definition of breakout downloads anywhere in the report. What does breakout even mean?
We need to be careful about the number of downloads. I suspect these downloads needed to be in 2021 to be included in this report. That means some popular apps that are on consumer phones before 2021 aren’t. Hence, the number of downloads in 2021 doesn’t paint a true picture of how popular apps are
With that being said, here are some takeaways in which I have some confidence.
Total App Spend in 2021 was $170 billion, implying iOS’ has a market share of 35-40%
App Annie estimated that the total app spend in 2021 at $170 billion. On Monday, Apple revealed that they paid $60 billion to developers in 2021 which didn’t include Apple’s commissions. If we assume that Apple takes 15% on every dollar, the total app spend on the App Store would be around $70 billion ~ 40% of the figure that App Annie reported.
Though their population isn’t too far off from each other, China had much more app downloads in 2021 than India
China has approximately 1.4 billion people in population, 20 million more than what India has. However, the number of app downloads in China easily dwarfs that in India and the rest of the world. I wonder if it’s because folks in China cycle their phones more often so that the number of downloads was high even though the number of users didn’t necessarily increase. On a side note, shout out to Vietnam with more than 3 billion downloads for a country with 97 million people.
LinkedIn was frequently searched on the App Store, signaling a vibrant job market
Zoom, Teams and LinkedIn are in the top most searched keywords on the App Store. That’s heartening for Zoom and Microsoft investors because this signals their brand awareness among users. The fact that LinkedIn is among this group signals to me that folks want to update their profile and look for job opportunities. Why else would you look for the LinkedIn app?
45% of markets where Disney+ is available have over 1 million downloads in total. The figure for Netflix is 31%
According to App Annie, there are 24 countries where the number of total downloads for Disney+ exceeded 1 million while there are 58 such countries for Netflix. However, it’s really important to remember that Disney+ is only available in 53 markets whereas Netflix can be downloaded in more than 190. Hence, you can see Disney+ tends to be really popular wherever it’s available.
Because of its reach and established brand in consumer minds, Amazon is a great channel for American sellers. Today, let’s take a look at the impact that Amazon has on these sellers during holiday seasons. This is by no means an easy task because Amazon offers data on a piecemeal basis and there is no standard definition of a holiday season. The lack of consistent reporting, the changing macro environments, seasonality and the different length of holiday seasons make it almost impossible to have a definitive view on how much American 3rd-party sellers grow their businesses on Amazon year over year. Nonetheless, below is my best estimate. Let’s go!
As sellers averaged 11,500 products per minute during the 30 day period from 11/26/2021 through 12/25/2021, it means that there were in total 496,800 products sold. From 10/4/2020 through 11/30/2020, which was Cyber Monday that year, U.S-based sellers averaged 9,500 products sold per minute, an equivalent of 793,400,000 items in total. Like 2020, the 2021 holiday season was also kicked off in early October. Assuming that the sales figures from 10/4/2021 through 11/30/2021 were about the same as the same period the year prior, U.S 3rd-party sellers would sell approximately almost 1.3 billion items in total for the whole season. Compared to the 1 billion figure in 2020, that means American sellers sold 30% more items on Amazon in 2021 than the year prior. A tremendous achievement at that scale.
In short, Amazon is still a great channel for American sellers, evidenced by a massive number of products sold during the holiday seasons and the estimated growth even at scale. Some critics often say that Amazon is no longer operating with the Day 1 mindset. It is debatable and in some aspects, they may have a point. But in this regard, I don’t see a slowed-down Amazon. I see an Amazon that is still growing impressively.
In this post, I’ll touch upon briefly the definition of a Super App, give a few examples and talk about the business implications of these apps.
The term Super Apps is generally credited to Mike Lazaridi, the founder of Blackberry, who defined it as “a closed ecosystem of many apps that people would use every day because they offer such a seamless, integrated, contextualized and efficient experience”. In laymen’s terms, a Super App is an application that offers various services on one interface. While the mix of services offered by Super Apps varies from one to another, the common denominators of these apps are 1/ they are all two-sided networks popular with both merchants and consumers and 2/ they all began their journey by being excellent in one function before branching out to others. Merchants need to have access to a lot of consumers to join a network while consumers only find the network useful when there is a lot of utility, namely plenty of merchants. The chicken and egg problem of a two-sided network is hard. Therefore, the singular focus on a vertical in the beginning makes sense as start-ups can’t afford to solve this issue in multiple verticals. No-one can build a Super App right from the get-go. Once an app excels and makes a name for itself in a vertical, why not leveraging existing traffic and offering users more reasons to stick around longer?
Examples of Super Apps
WeChat started out as a messenger app. An engineer named Allen Zhang alerted his employer Tencent on a threat of other competitors taking away its market share and app engagement. To stay competitive, WeChat transformed itself into an app on which users could do everyday things on a single interface including payments, social media, e-commerce, doctor appointments, hotel reservation or ride-hailing. The pivot was a hit as the new services surpassed even the apps that inspired WeChat in the first place.
Facebook and its founding story need little introduction. Over the years, Facebook has added several services to make itself stickier as a platform. Nowadays, users can shop on a marketplace or Facebook-native stores; create new connections with Facebook’s own Tinder version; make payments with Facebook Pay or consume exclusive content from creators. With its ambition and virtually limitless resources, it won’t be a surprise that Facebook or Meta will expand its offerings in the future.
The title of grab.com reads “Grab: The Everyday Everything App”. Its status as one of the biggest Super Apps in Southeast Asia is so different from its humble beginning. Grab was founded as a taxi-hailing business in Malaysia in 2012 by two Harvard graduates. The company gradually expanded into other areas, such as other modes of ride-hailing, food delivery & nonfood delivery, travel bookings, bill payment and financial services. In Vietnam, almost everyone in big cities uses Grab for daily tasks from food delivery, ride-sharing or bill payments.
Uber was founded in 2009 by Travis Kalanick and Garrett Camp as a ride-hailing alternative to taxies. The company’s meteoric rise saw it become a global phenomenon, but the company today is more than just a ride-hailing app. In 2014, Uber launched a food delivery service called Uber Eats, which was later rebranded under Delivery. While Covid-19 decimated the Mobility segment (ride-sharing) as riders were restricted by stay-at-home orders, the pandemic was a catalyst for the transformation of Uber as a whole. Delivery has been growing substantially due to consumers ordering food and grocery deliveries. Its gross bookings have repeatedly surpassed Mobility’s and now reaches Mobility’s pre-pandemic level. Second, the company has made strategic acquisitions to expand beyond food delivery. In June 2020, Uber acquired Cornership, a popular grocery delivery service in Latin America. A few months after, it added Postmates, which is very competitive in coastal cities and offers delivery-as-a-service for non-food items. In October 2021, Uber took over an alcohol delivery startup called Drizly. The company has been tinkering with marijuana delivery in Canada and waiting for the green light from the federal government before launching it in the U.S. Powered by the new capabilities, nonfood categories make up around 5-6% of Uber’s overall gross bookings and are expected to grow more in the future. Uber’s ambition is very simple: be the go-to app when consumers have a transportation need.
PayPal first made a name for itself by being a secure digital wallet and online payment system, especially as the primary checkout option on eBay. Since its spin-off from eBay in 2014, the company has added plenty of services to its mobile app and become a formidable two-sided network, due to relentless acquisitions and product development. End users can access various services on the current PayPal app, including paycheck deposit, high-interest savings, bill payment, remittance, credit cards, debit cards, in-store & online payment, BNPL, PayPal Credit, P2P payment, shopping deals and investing. PayPal’s end goal is to be the go-to Financial app for its users.
Cash App started out as a P2P payment app in which users could transfer funds to anybody in the U.S. Nowadays, users can pay for purchases in stores and online with Cash App debit card and Cash App Pay; invest in stocks and cryptocurrency; or make deposits into checking accounts. In November 2020, Square bought the tax filing division of Credit Karma and subsequently added to its flagship app the ability to file taxes and receive tax refunds. In August 2021, Square paid $29 billion for Afterpay, one of the major BNPL players in Australia and in the U.S. It’s just a matter of time before Cash App turns on BNPL for its users and merchants. Cash App’s ambition is similar to PayPal’s; which makes it interesting to see how the two compete in the future.
Pros and Cons of partnering with Super Apps
Merchants stand to gain an additional payment option as well as more sales from Super Apps, but the story isn’t all rosy. Too much reliance on Super Apps means that merchants’d risk ceding the control of direct customer relationships. In business, few things are more valuable than that. Take Apple and Amazon for instance. Apple’s customer base is so loyal and attached to their brand that almost all developers or other brands take the back seat in negotiations . Amazon’s scale and iron grip on the valuable Prime base allows them to dictate terms over merchants. When you buy from a merchant on Amazon, do you feel more related to the former or the latter?
For banks, Super Apps can have adverse impact in a couple of ways. First, services such as PayPal in 4, Afterpay, PayPal Credit or PayPal/Venmo credit cards can reduce issuers’ credit card spend and subsequently balance as well as revenue. Secondly, it’s in their interest to have users maintain an in-app balance and keep funds away from banks’ checking accounts. Think about it this way: would you feel more poised to use PayPal when your PayPal balance was $20 or $0? That’s why Venmo credits dormant users $10 for downloading and logging into the app again or why Square wants users to keep tax refunds in Cash App balance. The reduction in deposits can raise banks’ cost of funds as well as threaten to cut off the most fundamental relationship with customers.
On the other hand, Super Apps present a battleground for financial institutions vying for wallet share. Once the connection between checking accounts or debit/credit cards and these Super Apps is established, users often don’t want to go through the inconvenience of updating their default payment method. Hence, every financial institution wants to be the primary source of funds for consumers on these Super Apps to have a leg up over the competition. In this sense, Super Apps offer a business opportunity.
In summary, as you can see above, there are multiple paths towards the Super App status, whether an app’s starting point is to be in messaging, digital wallets or ride-sharing. I think all successful consumer-facing apps have ambition to gain the Super App status. If not, they’d do something wrong. It’ll be interesting to see how these Super Apps compete for mindshare as feature parity is established (meaning they all offer similar features). For merchants, working with Super Apps can be a double-edged sword. While the benefits these apps bring are very tempting, merchants need to keep in mind the risk of losing customer relationships. Like people usually say: don’t miss the forest for the trees.
Want to understand Affirm, what it does and how it makes money? Read on as I am discussing one of the most popular BNPL names below. My goal is 1/ to give you a better understanding of the company than a normal article on the news and 2/ not to overwhelm you with a 20-page essay with a lot of details. Ready? Let’s do it.
What is Affirm? What does it do?
Affirm was founded by Max Levchin, a co-founder of PayPal, in 2012 with the purpose of reinventing the payment experience for consumers and merchants. With Affirm, consumers can spread out a purchase over multiple payments over time without deferred interest, penalties or late fees. There are generally two types of transactions processed on Affirm platform: with or without interest. 0% APR transactions guarantee consumers a payment plan with no interest, fee or additional costs. Interest-bearing transactions carry an interest rate that never compounds. For instance, if a $100 purchase comes with an APR of 10%, $110 is the absolute maximum amount that a shopper will ever pay. The unpaid balance will not compound. All of the benefits give shoppers more purchase flexibility, especially those who are tight financially.
For merchants, Affirm helps increase sales through a bigger ticket size, more leads and more options at the checkout for consumers. When consumers can pay off a big purchase in installments, they are more incentivized to take on more expensive items. What merchants don’t want to sell their pricier products or services? In addition, as one of the most popular technology names out there, Affirm can bring hundreds of new leads – new businesses, to merchants. In exchange for all of these value propositions, Affirm charges participating merchants a fee on every transaction.
How does it originate loans?
When Affirm authorizes a transaction on its platform to a shopper, it is essentially giving out an unsecured loan. Even though Affirm itself doesn’t have a banking license to do that, it works with Cross River Bank and Celtic Bank, which help the fintech firm originate loans and comply with regulations at state and federal levels. Affirm is obligated to purchase the loans processed on its platform and originated by the partner banks. Such an obligation is backed by a cash deposit that Affirm has at these banks. The purchase price of a loan is the combination of its outstanding principal balance, a small fee for the banks’ trouble and any incurred interest. As a result, Affirm incurs an expense for every 0% APR transaction because they have to purchase the loan at a value higher than the fair market value of the loan. This expense is called “Loss on loan purchase commitment”.
Because the banks originate the loans themselves, they have the ultimate power to either approve or decline such loans and Affirm needs to underwrite within the risk parameters that the banks set. You may ask why banks need Affirm in this whole process after all. The answer is that Affirm brings in the ability to sign up merchants, the marketing expertise to appeal to shoppers and the capability to use machine learning to process data that can help better underwrite loans.
How does Affirm make money?
Affirm has multiple revenue streams. The first is Merchant Network Revenue, which consists of transaction-based fees. Every time Affirm processes a transaction on its platform, it takes a percentage cut from the purchase amount, coming out of the merchant’s pocket. The amount varies depending on a specific arrangement between Affirm and the merchant in question. Typically, Affirm earns larger Merchant Network fees on 0% APR transactions. Similarly, the firm earns a higher commission rate on higher value purchases. In some cases, in order to grow its user base by working with a giant partner, Affirm may not generate positive revenue and the loss is recorded as Sales and Marketing expense.
The second revenue stream is Virtual Card Network. This revenue stream essentially is comprised of interchange fees earned by Affirm for transactions on its platform. Apart from paying the Merchant Network above, merchants also have to pay another on every sale smaller fee called interchange. A portion of that fee, or I would say, the lion share of that fee will go to Affirm. Based on the aforementioned descriptions, it’s obvious that how much money Affirm can make in Network Revenue (Merchant Network + Virtual Card Network) in general hinges on how much transaction volume (GMV) it processes. Barring some caveats that I will explain later, GMV is a good indicator of Affirm’s health.
In addition to Network Revenue, Affirm also makes money from the interest on non-0% APR loans to consumers (Interest Income). These interest-bearing loans typically result in lower Merchant Network fees than 0% APR loans, but fill in the gap with interest. In Q1 FY2022 ending September 30, 2021, 57% of Affirm loans were bearing interest and the rest were interest-free. During the fiscal years 2019, 2020 and 2021, 45%, 37% and 37% of Affirm’s revenue came from this revenue stream.
The company can also leverage its outstanding loans for more income. It can sell part of its outstanding balance to any interested party and record Gain/loss on Sale. While keeping a balance on balance sheet can lead to more interest income, it comes with a charge-off (consumers don’t pay off) risk and additional expenses (cost of funds). By selling some of the balance, Affirm can recognize, usually, gain on sale and reduce its risk exposure. Moreover, loan owners can solicit Affirm’s expertise to manage the loans in exchange for a monthly fee or what the company calls: Service Inc
What are Affirm’s competitive advantages?
Affirm’s competitive advantages come down to two things: its two-sided network and underwriting capability. Let me expand on that.
While difficult to build at first, a two-sided network provides a real strong competitive advantage. More shoppers entice more merchants that make the whole ecosystem more appeal to new shoppers. To maintain and grow its two-sided network, Affirm needs not only consumers, but also merchants. So far, the company has done a good job at this by partnering with some of the biggest names in the U.S such as Target, Peloton, Shopify, Walmart and Amazon. By locking in popular retailers, Affirm becomes more popular among shoppers which, in turn, help it acquire more merchants and negotiate more favorable terms. By working with Shopify, Affirm can onboard a lot of merchants right away and appeal back to shoppers. I suspect that some of these partnerships (Walmart, Shopify and Amazon) come at a cost for Affirm as the company must make major concessions, but in the long run, it’s a smart move by its management. Who else can make the same claim that they are the BNPL provider for these brands?
The second advantage is its ability to use data analytics for underwriting. Underwriting unsecured loans is a tricky business. Quite often, the riskier customers are the more profitable as they pay interest income yet they can also default on the loans. The art of underwriting is to find a sweet spot between profitability and risk. If Affirm only had reliable borrowers, they could still make money with their business model. However, they would leave out folks who need POS-lending the most, you know, the folks with FICO less than 700 or bad credit history. This population is significant, but it can result in losses. This is a challenge for not only Affirm, but all the companies that are offering unsecured loans. With a lot of transaction data, Affirm can fine-tune their underwriting model to limit losses while expanding the customer universe.
It is an interesting and fairly complex business
It’s not straightforward to understand Affirm’s performance from one quarter to another. The first issue is the nature of the company’s partnership with strategic brands. The partnership with Peloton, while fruitful and successful in the beginning, gave the POS lending tech firm some headaches, such as its recall of products (it reduced the merchant network revenue by more than $5 million in FY2021), 0% APR loans that are more expensive to originate and the delay in loan recognition as well as revenue booking. In FY2021, Affirm facilitated $66.3 million more transaction volume than what was captured and reported by Peloton.
Even though GMV, at first glance, can be a good indicator of Affirm’s business health, how the company generates GMV affects its revenue streams heavily. A high concentration of low-value or interest-free transactions negatively affects the company’s top and bottom lines, as explained earlier, despite an excellent growth in merchant and shopper counts. Case in point, the number of active merchants increased from 29,000 in Q4 FY2021 (ending June 30) to 102,000 in Q1 FY2022 (ending September 30). while the number of active customers rose from 7.1 million to 8.7 million in the same period. However, revenue only increased by 3%, from $262 to $269 million. One of the main reasons is that the average order value decreased from $495 to $402 and the concentration of 0% APR loans went up from 38% to 43%. As the partnerships with Amazon, Walmart and Shopify ramp up, I expect the trend of a bigger ecosystem, lower AOV and modest increase in revenue will persist. But who knows? If Peloton roars back and brings more high-value loans or if Affirm signs a similar partner, the situation will certainly change. This makes it a bit tricky to analyze this business as it has more than meets the eyes.
Another factor is how much the company estimates its provision for credit losses. The fancy term essentially means how much of the loan is expected to be lost. This estimate depends on not only the concentration of 0% APR loans or new product lines with higher expected losses but also macro economics factors. At the beginning of the pandemic, Affirm expected higher losses, but the expectation subsided over time before it was normalized to the pre-pandemic level. Because we are not out of the woods yet with Covid-19 (thanks Omicron!), it’s not practical to have a consistent estimated provision for credit losses.
Lastly, and this one is more for the future: the regulatory risks. As of now, the BNPL field is largely unregulated, yet there are signs that it’s about to change. The Consumer Financial Protection Bureau already opened an inquiry into BNPL products and ordered information from the main players, including Affirm. Whether there would be new regulations in place, what such regulations and what the ramifications would be remain to be seen. Personally, I think that the worst that could happen is Affirm will have to deal with the same regulations as banks do. But the same would also go for other BNPL firms. As long as the fundamentals of the company are strong and not prone to collapsing under more scrutiny, Affirm should be fine.
In short, even though what Affirm does sounds simple on the surface, the inner workings behind the scenes and the numbers are not. I hope if you make it this far, you already have a better understanding of the company. Not too deep, but not too shallow either.
Disclaimer: I have Affirm stocks in my personal portfolio.
If you are looking for a strategy framework to think about a business’ competitive advantages, I recommend VRIO.
The name is an abbreviation of Valuable, Rare, Inimitable and Organized. Essentially, if a firm’s capability or resource is Valuable, Rare and Inimitable, and the firm itself is Organized, it has a sustained competitive advantage. The more sustained competitive advantages a firm has, the more robust its business model is and the more likely it is to succeed. Let’s take a look at a few real-life examples to see how applicable this framework is:
Apple is arguably the best in the world in combining hardware and software to produce great consumer products. Such a capability is absolutely valuable and rare because we don’t often see that in the market. Samsung or Huawei can make good hardware, but they don’t put hardware and software to harmonious use like Apple does. Google owns Android and is excellent at software, but they aren’t known for their hardware prowess. The fact that some of the biggest companies in the world haven’t been able to copy Apple means that this capability is hard to imitate. Plus, Apple, since Steve Jobs return, has been well-organized to leverage this capability with one P&L to promote singular objectives, the sway that the Industrial Design has or the new multi-billion dollar campus to encourage creativity and collaboration. Lately, Apple has bolstered this competitive advantage further with its own chip M1 and the rumored initiative to design its own 5G cellular chip. It’s precisely the ability to combine humanity, hardware and software that makes Apple products astounding success and itself the most valuable company (as of this writing).
Another advantage that Apple possesses is its world-class supply chain. Not many companies can operate a complex supply network that spans the world and have bargaining power over even powerful players like Foxconn, TSMC or Intel. Imagine that you have to work with suppliers in different countries for different parts, navigate through local regulations, coordinate delivery and transportation, and negotiate pricing while protecting the confidentiality of products. It’s monumentally challenging, but on the other hand, it’s valuable, rare and hard to imitate. Any new rival will have to spend years to put up the same network, and even then, it likely doesn’t have the power of Apple. Additionally, is Apple organized to leverage this capability? Tim Cook, the current CEO, is a supply chain wizard. The company COO, Jeff Williams, is also an Operations guy. The company is one of a few from the West to have a productive relationship with China and its government, despite all the political tension between the U.S and China. This type of relationship can’t be replicated in a short amount of time, if it can be replicated at all. Hence, supply chain is another sustained competitive advantage that Apple has to offer.
Aldi is a hard-discounter chain that originates from Germany and came to the U.S in 1976. The former CEO and President of Walmart, Greg Foran, labeled Aldi as “good and fierce”. What makes Aldi so? The discounter’s sustained competitive advantage lies in its long-standing culture and commitment to cut costs and pass on savings to shoppers. Here are a few practices that Aldi employs:
On average, an Aldi store’s size is about 12,000 square feet, compared to Walmart’s 178,000 and Costco’s 145,000 square feet. The smaller size helps drive down either leasing expense (if the land is leased) or depreciation (if the land is owned), as well as energy costs. Regarding SKUs, an Aldi store, on average, carries 1,400 items compared to 40,000 items by a traditional supermarket. The much smaller store size and more limited item selection lead to fewer staff required. An Aldi store usually has only 3-5 employees, a significantly smaller number compared to how many employees are present at a store like Walmart or Costco. The limited item selection enables Aldi to focus on its offerings and negotiate favorable deals with suppliers to keep costs and prices low. Another benefit is that a limited assortment doesn’t require complex marketing promotions, meaning that there will be no cost on marketing materials and labor.
Walking into an Aldi store, you won’t notice many decorations. It looks like an ordinary, no-fancy store and it’s by design to keep costs low. At Aldi stores, there is no free bag. Customers are encouraged to bring their own bags. Carts can only be used with a quarter coin. Customers retrieve the quarter upon returning a cart. This policy has long been part of Aldi’s signature operations. Additionally, customers have to bag their own groceries. A cashier will scan items and put them in a cart, but shoppers will have to take it from there. It speeds up the checkout process, increases efficiency and reduces the need for additional staff. As far as I know, there is no self-checkout.
About 90% of Aldi’s items are private labels. This private label centric approach allows Aldi total control over its selection and reduces the cost as well as complexity that comes with national brands. Private labels used to be unpopular among shoppers due to their cheap image. However, consumer preferences have changed. Astute shoppers, especially millennials, now have a much more favorable view on private labels because they are cheap and provide best value for money. According to Bain, 85% of American shoppers are open to buying private labels.
It’s certainly valuable to pass on savings to shoppers. While the practices themselves may not be rare, the commitment and the culture that enables consistent execution are. The frugal approach that empowers all the little things mentioned above has been nurtured and well-preserved since 1946 when the parent brand was founded in Germany. The only rival that has a similar mentality is Walmart. But the two chains differ in strategies. While Walmart has its hands in numerous cookie jars, Aldi’s bread and butter in the U.S is groceries in small stores with a small number of SKUs. In that segment of the market, I don’t see anyone with Aldi’s expertise and culture. As you can notice, it’s easy to copy a tangible element or an expertise of a business, but it’s much more difficult to replicate the intangibles like culture. Lastly, is Aldi organized? The brand is still one of the best, if not the best, hard discounters in various markets. In the U.S, it has been growing steadily since 1976 and becoming more popular among shoppers. So, I’ll say: yes, it’s organized!
Disney’s competitive advantage comes from its ability to consistently create excellent content loved by millions around the world. Any production studio can come up with a great movie or show once in a while. Disney is among a handful that can do it consistently. Take Spiderman: No Way Home as an example. It’s on track to net over $240 million in the first opening weekend while being the 27th Marvel movie since Iron Man in 2008. Over the last decade, Disney has dominated the list of highest grossing movies with hit after hit like Avengers: End Game, Captain Marvel, Infinitive War, Black Panther or Star Wars: The Force Awakens. While HBO is known for its quality outputs, even the famed studio isn’t as prolific as Disney. If you think about it, it’s all but nearly impossible to achieve what Disney has done, especially given that it owns the IPs such as Star Wars and Marvel franchise for eternity. Is it guaranteed to succeed long in the future? No. But Disney is more likely than any of its rivals to replicate its previous successes.
Another competitive advantage that this iconic brand has is its theme parks. Disney’s theme parks attract thousands of visitors around the world every year. As an important source of revenue and margin for the company, and a place for fans to connect with iconic movie figures, these theme parks are certainly valuable. However, they are not easy to create. Any company can pour millions of dollars into building and operating a park, but would they have the brand equity that Disney has with consumers around the world? Would they be able to lure enough visitors to make their park a financial success? To cultivate a brand or a cult like Disney does, a challenger needs to put out iconic content and characters year after year. That in and of itself is a monumental challenge that can’t be done in a few years’ time, if it can be done at all.
In short, VRIO is by no means the only framework to evaluate a business’ strength. We also have Porter’s Five Forces or Value Chain Analysis, just to name a couple. But VRIO is a very useful tool in analyzing a business’ competitive advantages and whether the business is great at anything it does. It’s one of my go-to tools when looking at a firm, as I demonstrated above. Hope this has been helpful for you.
I did a little bit of research on real-time payments and want to share here. It’s a big topic so I’ll likely add more in the next few weeks. In this post, I just cover why we need real-time payments, what it means and what it does. Let’s go!
Before we talk about real-time payments (RTP), we must first talk about ACH. Automated Clearing House (ACH) is a method that moves money digitally from one bank account to another in the U.S. Before ACH was born in the 1970s, consumers and businesses sent and received money using checks that required a lot of human input. As the number of checks increased, along with the payment volume, and payment preferences evolved, the banks realized that they needed a more efficient way to automate and speed up the sending and receiving of money. That’s how ACH came about.
What does ACH do exactly? It acts as a financial postal office that handles transactions between financial institutions. Every day, there are thousands of transactions initiated in the U.S. ACH operators sort these transactions, bundle by recipient and deliver them accordingly in several batches every day. Each of the batches includes instructions telling the recipient financial institution whether it is to make a debit or credit to accounts under its purview. At no point do any two banks exchange real money to settle transactions. Settlement is processed through the Federal Reserve.
There are two ACH operators: EPN and FedACH. The Electronic Payment Network (EPC) handles the fund transfer for the private sector while FedACH serves the same function for the federal government. The National Automated Clearing House Association (NACHA), a non-profit, serves as a trustee and a rule-making body of ACH. Collaborating with the government agencies, NACHA sets up rules that dictate how EPN and FedACH deliver messages.
Even if this is the first time you have ever heard of ACH, you must have already used it. ACH is how employers deposit salary to employees’ accounts, a customer pays a service provider every month, a customer pays a credit card, a business makes a payment to a supplier or IRS deposits tax refund to a taxpayer’s account. Compared to credit cards or wire transfers, ACH has its strengths. Credit cards aren’t available to many consumers, especially those with a bad credit history. Meanwhile, it’s far easier to open a checking or saving account which one can use to initiate an ACH transaction. For businesses, credit cards can mean a few percentage points in revenue losses due to interchange fees. ACH, on the other hand, is significantly cheaper. Wire transfers can enable a big transaction safely and quickly; however, they are usually pricey at $15 per transaction. Because of its accessibility and cost-effectiveness, ACH is very popular with 27 billion payments worth about $62 trillion in the U.S in 2020.
But ACH isn’t perfect. Because it is batch-based, ACH can take several hours, if not days, to confirm and settle funds. The delay can have ramifications. For instance, small businesses can run into cash-flow problems with delay in fund availability. The pending transactions and, as a result, the uncertainty regarding balance can put some consumers at risk of overdrafts. Consumers that pay bills on the last day of the grace period may incur late fess or even face stoppage of services because their payments won’t be cleared fast enough.
According to the Payments Innovation Alliance,a real-time payment (RTP) is “an immediate, irrevocable, interbank account-to- account transfer that utilizes a real-time messaging system connected to every end-user through a financial institution, third party, or another real-time system. Funds are available for use by the receiver and real-time confirmation is provided to both the sender and receiver in seconds”. While the requirement of immediate confirmation and fund availability is undebatable, there are conflicting opinions on whether settlement of RTP should be immediate. NACHA said that RTP settlement doesn’t need to take place real time. The majority of RTP systems today use a deferred net settlement method which offers a lower liquidity risk than a gross settlement method (settle transactions individually). On the contrary, The Clearing Houseclaims that RTP network payments “clear and settle individually in real time with immediate finality”.
Essential characteristics of RTP include:
Authorization or rejection of payment is within seconds
Fund posting and availability are within seconds
“Push” payments only
Use of ISO 20022 message standard. This will enable the transfer of richer data
Irrevocability. Funds are only transferred after sufficient funds are confirmed and when payments are sent, they are irrevocable
Availability of a proxy database that allows end users to send and receive payments without knowledge of the receiver’s bank account information
RTP benefits consumers and businesses in several ways. The constant availability and the immediacy of funds increase consumers’ convenience and help them manage budgets better. Thanks to RTP, some consumers may no longer have to live in anxiety with last-minute bill payments not clearing fast enough. With a proxy database, RTP can allow consumers to receive and send money without offering bank account details, a practice that makes me nervous every single time. All they need is a phone number or an email.
For businesses, there are multiple benefits that RTP can bring. They can refund customers and pay off suppliers right away, rather than a few-day delay. Who doesn’t want to get their hard-earned cash faster? Hence, customers and suppliers will field fewer anxious calls and be ultimately happier. Happy customers and happy suppliers mean happy life, I guess. In some urgent circumstances, the value of RTP will be even more highlighted. For instance, sometimes businesses are required to make unexpected same-day payments to authorities. They can use ACH and hold their breath that their payment makes it to one of the earlier batches. Or RTP can solve that problem instantly and hence, reduce regulatory and compliance risks. As receivers, the finality and irrevocability of payments will be a boon to businesses. Once they receive payments through RTP, they don’t have to worry about whether the senders have enough funds or will recall transactions. Plus, payments are cleared and settled right away. These two factors will help improve their cash flow management tremendously.
Another benefit of RTP is the use of ISO 20022 payment messages. The new standard is an improve over the old ones in the amount of data it can transmit and its structure. With the old standards, businesses can’t extract insights from the messages. In some cases, that can send false positive compliance issues leading to delays and higher expenses. According to SWIFT, poor data results in 1 out of 10 international payments being held up. The ISO 20022 payment messaging standard enables parties involved to attach a richer and more structured data to a payment. Data can include details of the remittance, the purpose of the payment, the original source and other relevant information. With this new data that can be processed more easily, businesses can reduce fewer errors, avoid delays, decrease unwanted reconciliation expenses, and gain valuable insights.
What are the RTP or faster payment services in the U.S?
First, let’s talk about the RTP network. It is the first core infrastructure in the U.S in more than 40 years. It was built and launched in November 2017 by The Clearing House, whose owner banks include arguably the biggest in the country. The RTP network is available to all federally insured U.S depository institutions and already reaches 61% of U.S demand deposit accounts (DDA).
Next is FedNow. It is owned by the Federal Reserve and is expected to launch in 2023. Once live, it will be available to all depository institutions in the U.S. The Federal Reserve said that FedNow will process messages and settle payments within 20 seconds. In the beginning, FedNow’s initial transaction limit will be $25,000, lower than the current limit imposed on the RTP network by The Clearing House.
Mastercard Send is Mastercard’s native method that enables instant payments between governments, businesses, and consumers. Mastercard Send supports disbursements – non P2P payments to consumers, domestic P2P payments and cross-border P2P transfers originating from the U.S. As of this writing, Mastercard Send is available in the U.S only and all domestic debit cards, including non-Mastercard cards. Interested issuers can tap into the Mastercard Send API to enable this capability.
Visa Direct is Visa’s equivalent of Mastercard Send with two major differences. The first difference is that while Mastercard Send is currently available in the U.S only, Visa Direct can be used in more than 100 countries. Secondly, its requirement for fund availability varies from one financial institution to another. In the U.S, Visa Direct mandates that all participating issuers make funds available within 30 minutes, a more relaxed approach than Mastercard Send, which claims that funds are available and settled within seconds.
Zelle is a mobile payment application developed by Early Warning Services, which is owned by Bank of America, Truist, Capital One, JPMorgan Chase, PNC Bank, U.S Bank and Wells Fargo. The application enables users to transfer funds from one to another without the need for account details. All it requires to initiate a transfer is an email address or phone number. Formerly confirming transactions within minutes, Early Warning Servicesannounced in February 2021 that Zelle transactions can now be cleared and settled in real time, officially making it an RTP network. Zelle users need to note that several banks place restrictions in terms of the number of transactions and transfer volume that a user can initiate in a month.
In December 2017, NACHA announced the launch of Same Day ACH, which enables the ACH payments to be processed faster and potentially settle in the same day, if a payment is submitted early enough. Despite this improvement, Same Day ACH isn’t an RTP method because transactions are still processed in batches and revocable.
Wire Transfers offer instant payment confirmation and settlement. However, unlike RTP, Wire Transfers are more suited for low-volume high-ticket transactions, limiting its value and accessibility to consumers and businesses. Compared to a few cents per RTP transaction that The Clearing House charges, a wire transfer usually costs at least $15.
Mobile payment apps such as CashApp, Venmo or PayPal allow instant transfers between users. Users can use their Venmo balance for purchases. What makes me unclear about whether these apps are RTP are 1/ they require users to use another payment rail to retrieve money. Customers who want instant transfers from these apps to their checking accounts will have to pay a small fee. 2/ will refunds go to bank accounts or Venmo accounts? If they go to bank accounts, how long will it take? 3/ Since not every merchant supports checkout with these apps, will it still be RTP?
In this post, I want to discuss Apple Pay & Apple Card
Natively available on almost every Apple device out there, Apple Pay is one of the most popular mobile wallets on the market. In 2020, 92% of mobile wallet transactions funded by debit cards in the U.S were through Apple Pay. This level of popularity can mean a windfall for Apple because for every Apple Pay transaction, the company is reported to earn 0.15% of the volume. In Q1 FY2020, Tim Cook revealed that the annualized Apple Pay volume was at $15 billion. At 0.15% take rate, Apple earns around $22.5 million in extra revenue for, what I would imagine, a very high margin service. Even with that advantage, I believe that Apple Pay still has plenty of potential to realize.
First, the wallet feature is still absent in many countries in Africa, Asia and South America, where a large portion of the world’s population resides. As the adoption of Apple Pay ramps up, it should increase the total transaction volume and consequently some additional revenue for the company. The second lever lies in how Apple Pay is and can be used. As of now, it is most used in online mobile transactions. In-store mobile transactions just don’t gain enough traction as there are only 6 out 100 shoppers that use the service in stores, even 7 years after launch. I don’t expect the in-store trend to change in the future. Where I do see growth opportunities for Apple Pay, though, is in online web transactions. As more customers upgrade from old Macbooks and iPads to more modern versions equipped with Touch ID and Face ID, it will make Apple Pay for web transactions an easier and more seamless experience. Finally, Buy Now Pay Later (BNPL). The whole market is red-hot and Apple is rumored to be working on its own BNPL solution. The big advantage for Apple here is that the feature comes in the Wallet app, which comes natively on every single device. Users don’t need to download any other app to apply. As the concept of BNPL becomes more common due to the popularity of apps like PayPal, Affirm, Klarna or Afterpay, Apple will just ride the coattail and won’t have to spend much money and time educating shoppers on the service.
Of course, I’d be remiss if I didn’t mention that there are also headwinds to Apple Pay. Companies such as Shopify, PayPal, Square, Affirm and Klarna all want to be the go-to app & checkout options for shopping transactions. These companies are well-known in the U.S and many international markets, as well as have enough resources to truly compete with Apple on this front. Hence, it won’t be all rosy roads for Apple Pay, but I do expect it to continue to grow in the future. If PayPal can process over $1.2 trillion in annual payment volume, it’s possible that Apple Pay could rise to $100 billion in volume, meaning $225 million in revenue and almost pure profit for the company. Since there are 1.65 billion installed devices in the wild, $100 billion in volume would translate to less than $100 per device a year. It seems doable to me.
Apple Card is a co-branded credit card issued by Goldman Sachs. The mega bank is about to close the GM portfolio purchase in the next quarter or two. Hence, their credit card balance is mostly, if not entirely, from Apple Card. According to the latest quarter result, Apple Card balance was $6 billion as of September 2021, up from $3 billion just a year ago. In other words, the Apple Card portfolio doubled its outstanding balance in 12 months’ time. The size of a co-brand portfolio is often a private matter, but I managed to find a few as a reference for Apple Card
A portfolio’s outstanding balance changes from day to day. Therefore, these numbers may be very different from now. Plus, these companies have a different business model, brand name and card offering than Apple. Nonetheless, I do think growing a credit card portfolio to $6 billion in loans in two years is not a small feat.
According to Experian and ValuePenguin, the average credit card balance in the U.S has been a tad more than $6,000 between 2019 and 2021. If we apply that number to the Apple Card portfolio, it means that the portfolio has a bit less than 1 million accounts. However, given that Apple Card doesn’t have a big signing bonus or intro offer and it can only earn 2% cash back when used with Apple Pay, I think that the average revolving balance is lower than $6,000. In fact, I think it’s very common that people just get an Apple Card because 1/ they want a nice-looking metal card and 2/ they want to put their big Apple purchase on installments. In the latter case, an Apple purchase should range from $1,000 to $3,000 in most cases. As a result I’d think that Apple Card’s average card balance likely ranges from $2,500 to $4,000.
Average Revolving Balance Per Account
# of Accounts (in millions)
The number of accounts can determine how much money Apple can get from this arrangement with Goldman Sachs. In the cobrand credit card world, the issuer has to compensate its partner for leveraging its brand. The compensation includes a finder’s fee (a certain amount for a new account opened) and a profit sharing agreement which may be based on interest income or purchase volume, for instance. I have seen smaller brands command $60 per a new account. Hence, it won’t surprise me one bit if Apple can demand a three-digit finder’s fee from Goldman Sachs, given that Apple shoulders all the marketing efforts. At $100 per a new account, 1 million accounts brings in $100 million in revenue for Apple. Even if we factor in the marketing and reward expenses that Apple might incur, it’s possible that Apple can bring in more than the $100 million figure since we know nothing about the profit sharing part between them and Goldman Sachs.
In short, even though these two services have great potential and can bring in meaningful revenue and margin to Apple, given the size of the company, they won’t move the needle much. Instead, they are great value-added services that enhance user experience on Apple devices. With Apple Pay, transactions on every website or app that enable the service are so easy to process. With Apple Card, it’s likely the only product that come with no fees and installment plans every time you make a big Apple purchase. As long as Apple users remain loyal and attached to the company’s devices, these services will have the runway to grow. Remember that Apple Card so far is only available in the U.S.